November 2005
Reinsurance
Reinsurance
(Oct 2007) Ruxley in landmark reinsurance-funded acquisition(Apr 2007) Ruxley in Generali run-off talks(Autumn 2006) Part VII business transfers - adding flexibility to the run-off equation(Spring 2006) Why we need a scheme monitor(Spring 2006) BAIC and after(Feb 2006) Solvent Schemes of Arrangement Conference(Nov 2005) Scheming for solvency(Oct 2005) A wake-up call(Sept 2005) Time To Wake Up(Sept 2005) Free Audio Conference: Rating the Raters(Aug/Sept 2005) Air Your Views(Aug 2005) Ruling could curtail solvent runoff schemes(March 2005) Tackling The Pools(Spring 2005) Selling like hot cakes(Spring 2005) The scheming solution(28/02/05) Influx of capital can impact premiums(Feb 05) Bringing finality to underwriting pools(Winter 04) Dangerous waters(04/11/04) Solvent schemes offer real boost(01/09/04) Buying Run-off(05/07/04) Run-off moves to another level(03/02/04) Run-off on a positive note(2004) 2003 A year of innovation(Winter 03) Ruxley buys Aviation & General(06/10/03) Ruxley takes whole of A&G(04/07/03) End of asbestos saga?(03/07/03) Ruxley closes APH book(Summer 03) Vulture Culture?
In the context of an insurance run-off, a solvent scheme of arrangement is a consensual agreement between an insurer and its policyholders designed to bring discontinued business to an early and final close, so enabling all concerned to avoid the future costs and management distraction of the continued run-off.
The solvent scheme per se is a much wider corporate tool which is designed to facilitate consensual changes to corporate structures such as mergers, acquisitions and re-structuring initiatives including reorganisation of debt and capital. Accordingly, the legal framework is provided by section 425 (s425) of the Companies Act 1985 which set outs various procedures to ensure the fairness of the process and requires schemes to be sanctioned by the UK Courts.
In essence, in order to allow such transactions to move forward, the Act provides for the view of the majority of creditors, (over 50% by number and 75% by value) to be binding on a company and all its scheme creditors once a scheme is approved.
How do schemes for insurance run-off compare to s425 schemes applied in other areas such as mergers and acquisitions?
Insurance solvent schemes of arrangement differ from mainstream corporate initiatives in two ways.
On the technical side, the process for apportioning voting rights is usually more complex as, unlike most corporate schemes where the calculation is based on the proportion of shares held by each affected party, for run off portfolios the calculations are based on the total claims value of each affected party including claims that have been incurred but not reported (IBNR).
On the implementation side, there seems to be a much greater appreciation that s425 only provides the legal framework that makes schemes possible and therefore, the key to success is the quality of the communication and consultation that sits behind schemes.
In M&A schemes for instance, the relevant creditors or shareholders are consulted well in advance of a scheme being proposed with any concerns being dealt with by negotiation before (and during) the scheme drafting process. This way, a scheme proposer avoids the high cost of developing a scheme only to see it fail because creditor concerns have not been properly addressed.
While the insurance sector seeks to take this approach, recent experience indicates that on occasion the industry is still less expert at this process than its corporate counterparts.
What are the advantages for policyholders of a solvent scheme?
Solvent schemes can offer significant potential advantages to policyholders, the most obvious being that of replacing uncertainty of payment - for example, that an insurer will be around to meet claims in the longer term – with certainty.
In addition, achieving finality sooner rather than later can lead to savings in management time and legal expenses while also delivering wider potential financial benefits. For instance, in order to expedite a rapid resolution, a well - managed scheme may aim to pay claims at a higher estimate of future liabilities than a policyholder is likely to receive under a normal run-off.
Separately, while a discount for time value of money is applied to claims payments, this may be based on an advantageous assumption of investment returns. By receiving all payments immediately and investing those funds to achieve higher-than-assumed returns, policyholders can significantly increase the total funds received over the same period.
What kind of run off business can solvent schemes be applied to?
They can be used with most run-off business provided that a reasonable estimate of the future claims arising under the contracts falling within the scheme can be made, and the policyholders are sufficiently sophisticated to understand the scheme process and its implications.
Reflecting this, schemes are not regarded as being suitable for personal-lines business where the policyholders will be the normal ‘man in the street'. There are also a limited number of insurances, such as UK employers' liability cover, which insurance regulators have excluded from being schemed.
Where can they be implemented?
In addition to the UK, there are various jurisdictions - usually those with a legislative system similar to that of the UK – where the company legislation exists to allow solvent schemes. Reflecting this, to date, schemes have been proposed in Ireland, Singapore and Hong Kong. The State of Rhode Island also has legislation that would allow solvent schemes, but this has not yet been tested as.
Why are they such a favoured option for closing discontinued portfolios?
First, solvent schemes are the only practical method by which a run-off can be brought to a swift, certain and binding finality. Alternatives such as loss portfolio transfer reinsurance and adverse development covers simply recycle the risk within the market and the liabilities can fall back on to the original insurer in the event of reinsurer failure or limits being exceeded.
Second, the legal framework provided by s425 is very flexible, so allowing the terms of individual schemes to be tailored to the specific circumstances of each portfolio. Given the consensual nature of solvent schemes, the ability to create a bespoke solution is fundamental to their viability from a policyholder standpoint.
What makes the difference between successful and unsuccessful schemes?
Because they are a consensual arrangement, the key ‘success factor' is the quality of the design, planning and implementation that supports such initiatives rather than any legal factors.
Properly preparing for the policyholder consultation process requires a number of specialist steps as follow.
First, portfolios need to be analysed down to the individual policyholder and policy level, actuarial best estimates for portfolios need to be compared against market estimates and various factors - such as whether outstanding claims have been updated regularly in light of market developments - need to be verified. As part of this, policy records need to be assessed to ensure that such factors as policies that have not yet triggered (but are likely to do so) are caught early.
Second, existing systems need to be adapted, or new ones created, to support the solvent scheme (as opposed to run off) process. The critical factor in this transition is developing a creditor's (rather than individual claims') view, which enables a comprehensive picture to be developed of each policyholder's total position, including IBNR.
To do this, a wide number of issues need to be addressed, ranging from housekeeping activities (such as updating contact details and consolidating all creditor policy and claims information into one file) through to incorporating wider claims-assessment factors in to the overview, including relevant attorney reserve information, actuarial estimates and market policy and claims information.
Third, widespread policyholder consultation needs to take place, so that the scheme manger can address any specific concerns and assist creditors through the voting and claims procedures.
This all means that by the time a scheme is proposed there should be little likelihood of surprises for the vast majority of those affected.
However, the expert management required does not end at the Sanction Hearing, especially as the mutual benefits of schemes are usually dependant on achieving swift closure once a scheme is approved.
Accordingly, in addition to ensuring the claims-assessment process is fair and consistent across all creditors, policyholders may need to be encouraged (and in some cases assisted) to submit correctly completed claims forms.
Why have some policyholders been unhappy with recent schemes and how can their concerns be addressed?
Policyholders have expressed concerns over a wide range of aspects of schemes (including late notice of the proposed scheme and insufficient time to prepare the required information and analysis to substantiate a vote or a claim under the terms of a scheme), but these are all symptoms of a basic fault – lack of appropriate implementation expertise.
These issues can be addressed by in-depth consultation and communication with as many creditors and as early as (well in advance of the scheme being formally proposed) to ensure that the design, drafting and execution of scheme responds to policyholder concerns.
Why have they been under particularly close scrutiny recently?
The recent close scrutiny of schemes has resulted from creditors feeling unhappy about how they have been treated during the planning and implementation of the scheme. In essence, the problems of poor communication and drafting.
This has been a developing issue, in part because as schemes have become more common there has also been a growing perception that they are easy to execute – perhaps because the focus has been on the legal process underpinning schemes rather than on the detailed work required to support them.
This unease was recently underlined when policyholders decided to challenge the British Aviation Insurance Company Ltd (BAIC) scheme proposed at its High Court sanction hearing. As the challenge was successful, the whole issue of how to develop and implement schemes has been thrown under the spotlight.
What are the implications of the BAIC ruling for future schemes?
Given the BAIC sanction ruling is currently the subject of an appeal - and certain elements of the BAIC judgment have also been questioned in the more recent M&G Re sanction hearing, which was heard under Scottish law - its implications are currently uncertain. However, creditors clearly have concerns about schemes and are prepared to raise them in court and thus may potentially block a scheme.
What are the potential pitfalls for those considering proposing a scheme?
As highlighted earlier, the skills required to successfully implement a scheme are very different from those required for run-off. Successful management of a scheme is a highly proactive process, requiring excellent negotiation skills and a shift to a policyholder (rather than claims) view with all the relevant implications.
Accordingly, the key risks derive from a lack of the relevant skills and, crucially, experience to carry out the numerous ‘behind the scenes' analysis, communication and consultation activities that enable an appropriate scheme to be developed and implemented.
What if this option were no longer available to risk carriers?
If solvent schemes were no longer available, the market would return to the dark days of the late 1980s and early 1990s with significant amounts of capital, staff and management resource being trapped by the demands of run-off portfolios, and the US Courts choked with litigation between policyholders and insurers.
Just as important, insurers' ability to respond to policyholders' future needs would be impeded by their inability to shake free from the ‘legacy drag' of the past.
